- It is a valuation technique popularized by Bruce Greenwald, an authority on value investing at Columbia University.
- It is a better way than DCF that relies on higly speculative growth assumptions many years into the future.
- EPV assume no growth, but make asssumption on [1] the cost of capital and [2] the current earnings are sustainable. And, it also invovles several adjustment to clean up the underlying earnings figures.
- Cyclical Adjusted Operating Earnings:
- To normalized EBIT to eliminate the effects on the profitability of valuing the firm at different points in the business cycle.
- Taking a long term (say 5-8 years) average of EBIT to include at least once economic downturn.
- Normalizing for non-recurring charges:
- To deduct the normalized long term average of non-recurring charges to determine the adjusted and cyclical normalized operating earnings.
- Normalized Taxation Adjustment: A normalized tax rate could either be
- [1] the average tax rate of the company over, say, the last 5-8 years, or
- [2] the general corporate tax rate to avoid the distortive effect of different tax schemes (in Malaysia, this has been 25%).
- Economic Depreciation Adjustment:
- Adding back the after-tax depreciation of the most recent year - it may not reflects the true economic cost of depreciation.
- Economic depreciation is the cost to the company to make it at the end of the year in the same situation at the beginning of the year, i.e. maintenance capital expenditure.
- Economic depreciation = CAPEX - Growth CAPEX
- Growth CAPEX = Average of Gross PPE/Sales Ratio of long term (5-7years) * Current Year's increase in sales.
- Adjusted After-Tax EBIT:
- The firm’s distributable cash flow.
- It can then be divided by the company cost of capital to derive Earnings Power Value for the Firm.
- Cash/Debt Adjustment:
- To subtract out any corporate debt and add in cash in excess of operating requirements
- Divide this by the number of shares to get the EPV implied Share Price Value.
- It evaluates a company based on its current situation - It potentially a weakness in that it may systematically undervalue growth companies. In normal markets, it may even be difficult to find a company that's selling for less than its EPV.
- Earning might be manipulated - Old School Value notes, “Enron had
great earnings all the way up to its collapse but free cash flow foretold the
troubles long before the scandal surfaced”.
If current earnings aren't sustainable, you'll get an EPV that is too high.
References:-
No comments:
Post a Comment